Chancellor Angela Merkel's resounding re-election in Sunday's vote obscures two problems for the euro, one German and one European that could weigh on the currency in coming weeks.
Ms Merkel’s Christian Democratic Union (CDU) received 41.5 percent of the vote, 7.7 percent better than its 2009 performance, but it fell five seats short of an absolute majority in the Bundestag. Ms Merkel will have to form a coalition to govern.
Her former coalition partner the pro-business Free Democratic Party (FDP) obtained only 4.8 percent of the vote and fell short of the required 5.0 percent for parliamentary representation. Of the other represented parties, the Left at 8.6 percent and the Greens at 8.4 percent are ideologically anathema to the conservative CDU. That leaves the center-left Social Democratic Party (SPD) led by Peer Steinbruck, which came in second with 25.7 percent of the vote.
Mr Steinbruck will want to extract the greatest possible price in policy and cabinet posts for the SPD’s participation in a so-called 'grand coalition'. The newly formed anti-euro Alternative for Germany (AfD) party which called for "an orderly dismantling of the euro zone" and began life just this past February scored 4.7 percent.
The price for a SPD coalition, the negotiations could stretch on for months, could be the finance ministry and SPD polices such as minimum wage and higher taxes for top earners, which markets would likely see as damaging to the Germany economy and the euro.
The continent’s largest economy has been an island of stability in a sea of European turmoil. Germany’s 6.8 percent unemployment rate is a little more than half the 12.1 percent in the 17 nation currency union.
On the European side a coalition could usher in a softening of Merkel’s austerity approach to the European debt crisis and the struggling Euro members who have received bailouts.
Greece began negotiations with its European creditors on Sunday that will probably set the conditions for a third bailout of the indebted Mediterranean nation. At point will be the additional budget cuts needed to close a potential €2-4 billion budget deficit next year and a forecast €2.5-4 billion deficit in 2015-16. The size of the deficits will determine the amount of a third Greek bailout needed to cover debt payment and other financing between July 2014--when current European loans expire--and mid-2016. An additional €11 billion in funds related to the various government bond deals that staved off bankruptcy could be needed by the Athens government according to IMF.
While the Greek government says that the budget will be in primary balance this year, that is before interest payments and the economy is showing some signs of improvement, protest and social unrest against the austerity enforced by her European partners could well unseat the five seat majority of Prime Minister Antonis Samaras.
Merkel’s negotiations with the SPD and the Greek government’s tussle with the Troika will play out in public over the next few weeks.
Neither the German political negotiation nor the Greek debt and bailout discussion will feature positive details for the euro. Each will highlight the risks ahead for the united currency and the European financial system and economy. There is likely to be a market toll for such exhibitions.
Chief Market Strategist